BP's new Russian excursion is a risk worth taking

It’s easy enough to pick holes in BP’s latest Russian excursion. There are five main areas of risk.

One is that it further alienates the Americans, some of whom are already switching their moniker for BP from Bad Petroleum to Bolshoi Petroleum.

Another is that BP, having already fallen foul of the Russian bear twice since it entered the market in the early noughties, will only get burnt again. This is still a gangster economy, where the rule of law remains somewhat pliable, to put it mildly.

BP deliberately tried to curry favour with Vladimir Putin by participating in Rosneft’s original IPO, back in 2006, but it profited the company nothing. When TNK BP’s Russian partners deployed strong arm tactics to take control of the venture, in breach of the original agreement, Putin couldn’t be seen for dust.

Beyond the generalised risks of doing business in Russia, there are some more specific ones. BP’s partners in its existing Russian operation, TNK-BP, are already complaining that the Rosneft transaction breaches an agreement by BP to pursue new ventures in Russia only through the existing alliance.

Just as potentially fraught, Rosneft is the main vehicle for holding assets sequestrated from Yukos, the company that used to be controlled by Mikhail Khodorkovsky, a former oligarch jailed ostensibly for tax evasion and theft, but in reality for kicking against Putin politically. That jail sentence was recently extended on more trumped up charges.

Fourth and most important, the Rosneft tie up might be thought of as just a bad deal all round. Production from these territories is a good ten to fifteen years away, and will in the meantime require very substantial capital investment. That makes it the opposite of the TNK alliance, which despite its turbulent record, has always been strongly cash positive for BP and therefore already paid for itself many times over. Nobody is too sure about what’s under these particular arctic waters or how exploitable it might be.

Then finally, there is the share exchange element to the deal, which is mildly dilutive to existing shareholders at a time when the share price is already at a low ebb.

Dealing with each of these points in turn, American sensitivities must obviously be recognised – the US is still BP’s largest market by some distance – but shouldn’t be taken too seriously. Exxon was also gagging for this deal, but lost out because BP was thought to have the edge on exploration technology and because it was not prepared to contemplate the share swap element. American hostility to the deal is just sour grapes and unlikely to be significant over time.

On lack of legal protections, well that’s nothing new for Big Oil. High political and legal risk comes with the territory. The world’s dwindling reserves of oil mean that companies must seek opportunity in ever more politically and environmentally inhospitable places.

Neither the TNK fly in the ointment, still less the now luckless Mr Khodorkovsky, are likely to be durable threats to the new agreement. It’s possible there will be an eventual cost in settlement, but it’s unlikely significantly to undermine the economics of the deal.

As for the risks of doing business in Russia more generally, resource extraction is the only truly globalised part of the Russian economy, with around a quarter of oil coming from foreign operators. For this reason alone, Russia has to be rather more sensitive to international norms on business law in the area of oil than is perhaps common in commerce more generally.

On the dilution, and the still unproven nature of the reserves, that's just the price BP has to pay for sealing the deal. After the disaster of the Gulf oil spill, BP desperately needs to get back on the front foot. To do so, it must take risks.